Banks seem keen to be green. The number backing the Green Bond Principles has doubled in a few months. The principles, drafted by a committee comprising Bank of America Merrill Lynch, Citigroup, Crédit Agricole Corporate and Investment Bank and JP Morgan Chase, were announced in January with the backing of nine other banks. This month another 12 declared their support.

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There is one problem, though: the principles do not define greenness, but give guidelines for issuance. Offering guidelines for issuing green bonds without defining what they are begs the question of what exactly is “green” and how rigorously definitions should be policed. That question is only likely to become more important as the market grows and diversifies.

Last year there was $11 billion in issuance, as much as in all previous years combined, according to Dealogic. Issuance in 2014 to date has already totalled $10 billion.

Green structures

The market has been dominated by supranationals like the World Bank and the European Investment Bank, issuing plain vanilla bonds. But new structures are coming to market (see right) and corporates have begun to issue, some in considerable size.

They are also diversifying their use of funds. French utility EDF’s €1.4 billion inaugural green bond, launched in November and earmarked for green energy projects, was easy for investors to understand.
Consumer goods group Unilever’s £250 million green bond in March was more complicated. The proceeds will fund new factories and expansions, designed to halve waste, water usage and greenhouse gas emissions. Unilever has asked DNV GL, the Norwegian certification organisation, to vet these more complex metrics annually.

The voluntary Green Bond Principles support the certification of green bonds against “fully developed and vetted” standards, though it does not go so far as to propose a single global standard. Until now, issuers have been well-known, trusted names, but as they proliferate, investors may want independent assurance that green means green.

Different organisations have developed their own definitions of what constitutes, say, green transport, waste management or land use. Development banks have evolved internal rules to guide their own green lending. Some issuers seek approvals, or “second opinions”, from third-party agencies like Cicero (the Center for International Climate and Environmental Research in Oslo) and Vigeo, the French environmental, social and governance assessment firm. The Climate Bonds Initiative, a lobby group, has been drawing up its own detailed green taxonomy, the Climate Bonds Standard.

Related

Consultants, as well as investors, exhibit differing shades of green. For some, retrofitting pollution-reduction technology at coal-fired power plants is green. For Cicero and the Climate Bonds Initiative, it is not.

Many environmental lobby groups classify nuclear power, although the generation process is carbon-free, as un-green. Yet EDF, seen as essentially a nuclear company, was able to issue the largest-ever green bond, with 55% of demand coming from socially responsible investment funds.

Is a single certification and monitoring authority desirable, or even possible? The World Bank thinks that guidelines are useful but that they should not be too stringent and that it is ultimately up to investors to decide.

Single standard

The Climate Bonds Initiative wants a single standard, but accepts that it would be difficult to impose this early on. Its chief executive, Sean Kidney, said: “At this stage, issuers just need to be clear which definition they are using. They need to reference something that people can understand and check.”

The Green Bond Principles stipulate that, to qualify, bond proceeds must be exclusively applied towards new and existing green projects, via specified use of proceeds, direct project exposure or securitisation. No champion of the market wants to see a green bond being “downgraded” – losing its status because the money was spent on something less than green.

“It could happen in theory,” admits Ulrik Ross, HSBC’s global head of public sector DCM and the bank’s green bond product sponsor. “It would certainly be bad for the market, since its integrity rests on the fact that proceeds are used for the right purpose, though the issuer itself would suffer most in terms of investor confidence.”

Investors with tight SRI mandates would have to sell such a bond, incurring losses. Kidney agreed that any downgrade would be bad news. “The market might deflate like a soufflé,” he said. “That’s another reason to have common standards.”

One colour, different shades

Green bond structures, issuer types and currencies are multiplying, and some bankers forecast expansion into all segments of the fixed-income market.

Toyota Financial Services issued the motor industry’s first-ever asset-backed green bond in March. The deal, which reportedly began as a $775 million transaction, attracted enough interest to be upsized to $1.75 billion. While it is backed by a conventional mix of auto loans, Toyota has ring-fenced the proceeds to fund new retail finance and lease contracts for “green” hybrid and low-emission vehicles.

A different kind of ABS deal was engineered by Hannon Armstrong, a US-listed sustainable infrastructure investor. It grouped together the cashflows from more than 100 wind, solar and energy-efficiency installations to create a $100 million securitisation, with a 2.79% coupon. This first “sustainable yield bond”, as it called it, was privately placed but the firm is planning more.

This addresses the problem of issuance that would otherwise be too small and illiquid for the bond market. Sean Kidney of the Climate Bonds Initiative predicted: “Aggregation will be a growth area in 2014 and 2015.” He added: “The mixed portfolio will be critical, because there is probably not enough dealflow in one single silo.”

The World Bank recently issued its first Kangaroo green bond, for A$300 million ($278 million). City and regional bonds are set to grow – Sweden’s Gothenburg sold a Skr500 million ($76 million) green bond in September, and other cities such as Johannesburg are expected to follow.

Vince Purton, head of debt capital markets at Daiwa Capital Markets said: “All areas of the conventional market could have ‘green bond’ nomenclature.”

He added: “There will be a huge variety and diversity of green bonds going forward.”

This article was first published in the print edition of Financial News dated April 28, 2014